Pennsylvania Investment Observer

Tax Relief

by Daniel J. Nestlerode

President George W. Bush just got Congress to vote in favor of the largest tax reduction package since former President Reagan’s historic tax reduction bill in 1981. I presume that President Bush will sign this bill into law in the next few days. What followed the 1981 tax reduction was the beginning the of the great bull market we have experienced since 1982. While the tax rate reduction in 1981 was not the only element in the recovery of the investment markets it was, in my opinion, one of the important pieces that led to the economic recovery after the disastrous Nixon/Carter years.

Despite all the talk about this tax reduction, it is a rather small and inconsequential tax reduction act. The benefits of this act are phased in over the next ten years. So if you were looking for a big reduction in your 2001 taxes, you can forget it. Politicians being what they are, however, they did throw us a bone they can take credit for in the next election. If you file your federal taxes as a single person, then you will probably receive as much as a $300 refund some time this fall. Single folks filing as head of households will get as much as a $500 refund and married folks filing jointly will get up to a $600 refund. The whole notion of the Internal Revenue Service (IRS) sending checks out to nearly every taxpayer, rather than taking money in is a great idea. Now if I could just get them to file an annual report telling me what they spent my money on, I would be more pleased. However, one step at a time is probably in order. As you can tell, I am not fan of large government, high tax rates and big tax bills every year.

The marriage penalty tax got some attention in this tax bill. Starting in 2005, the tax code will be adjusted so that married couples filing jointly will pay an amount closer to couples living together and filing singly. I got married in 1999 and was well annoyed, to put it mildly, at the increase in the amount of money I had to pay the federal government just because of a change in my marital status.

The childcare credit will be increasing from $500 per child per year to $1000 by 2010. This will help my son and his wife pay for day care for my granddaughter. Let’s see, day care costs $700 per month and the credit is now $500 a year. Clearly, this is another bone to appease taxpayers. However, the credit is a country mile from really handling the city costs of day care. Contributions for IRA and 401(k) plans are to be increased also. This is great because now I can put away more money for retirement.

Finally, and most importantly, the inheritance tax is going to be eliminated by 2010. If you believe that I will tell you another story. Any bill taking effect now that looks nine years into the future gives subsequent congresses and administrations ample time to change their collective minds. Call me a skeptic. However the intent is great. If we can really eliminate any tax entirely, then there is hope that the federal tax monster can eventually be brought under control. Clearly, however, the return of the control of the Senate to the Democrats (because of the Senator Jeffords switch to Independent from Republican status) leaves the door open for the Democrats to chip away at this bill and negate the provisions that are supposed to take effect in the coming years. With Senator Hillary Clinton now in charge of the Senate Health Care Committee, I suspect there will be many spending bills promoted for the good of hard working Americans, putting the tax cut bill in jeopardy.

What does all this have to do with the investment markets? The markets generally like tax reductions. Former President Reagan’s tax rate cuts led to sharply increased government revenues. That’s right, at these tax rate levels; lower tax rates lead to higher government revenues. Lower tax rates lead to more economic activity that results in more money for the taxpayers and the government! In my book, this is a win-win situation. More economic activity also means that corporations will be busier and will likely have more profits. This generally leads to higher stock prices. This could be a win-win-win situation. The new bull market needs all the help it can get from congress.

Nevertheless, my gut instinct tells me that the market is not likely to advance sharply in the months directly ahead. Rallies in the stock market rarely start in the summer months. More conservatively, I expect the stock market to mark time this summer and begin a good rally in the late fall, unless the Democratic Senate submarines the newly passed tax reduction.

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